As I’ve mentioned before, Mohnish Pabrai is my favorite value investor. Reading his writing, listening to his speeches and reading transcripts of his debates has given me a valuable insight into the world of investing from someone who is one of the most thoughtful investors ever to have walked the face of the planet.
This article is devoted to part of a discussion between Pabrai, Guy Spier and Michael Shearn at the ValueConferences Best Ideas January 2014 conference.
Early on in the discussion, the trio began to talk about the importance of having an investment checklist that can streamline your investment process and ensure that you don’t make the same mistake twice:
“I think checklists, just like in aviation, we have such a low rate of air crashes and fatalities in crashes, and checklists are, to a large part, responsible for that. They are a tool that carries a lot of weight without adding a lot of burden. For example, typically when I run the checklist for the first time when I’m looking at an investment is actually the last thing I do before making an investment – it usually takes no more than 15 to 20 minutes, maybe 30 minutes max to run it, but the first time I run eight, it actually pops up all sorts of questions to which I don’t know the answer. That’s the biggest value addition, which is there are these blind spots that I have completely ignored. Then I go back and research the business some more to get answers to those questions and sometimes that can take a week or longer. Then I re-run a second time. Now the second time when I re-run it, we’ve got all the questions answered, and we can see the failure of possible failure points.”
Checklists have helped both Spier and Pabrai significantly reduce their loss rate over the years; properly implemented a checklist can be a hugely beneficial tool that is very easy to put together and simple to process. The talk goes on:
“There are no businesses that will get a clean bill of health on all 97 questions –Â that’s not going to happen in virtually any business –Â but it demonstrates very clearly what are the issues that could cause a problem, and it forces you to think about it and try and weight your mind what the odds and probabilities are of those sorts of events coming to pass.”
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“The error rate at the Pabrai Funds over the last five years is almost nonexistent. I think there have been only two situations where we’ve had a permanent loss of capital. The total amount of capital we lost in these two cases was $5.5 million out of more than $500 million in investments so kind of less than 1% loss ratio.”
Checklists are an important part of Pabrai’s investment process that he uses to minimize losses and hunt out only the best stocks. But a simple list cannot fulfill your entire investment process; sometimes you need to understand that industries can change and go through periods of “rationalization” that may make them more investable than they have been in the past:
“Probably worse than the disk drive business is the DRAM business. That’s a dog-eat-dog world, horrible business. Intel (INTC, Financial) used to be in the business; they exited. DRAMs, again, have gone through the same process that airlines and disk drives have gone through and it's consolidated down to, I think, three players. Of course, one advantage or common element all three of these industries have is that they have very high Capex and especially in DRAMs and disk drives; it’s very hard to enter the business. Airlines you can just enter relatively easy, but these other two are much harder. I missed all three, and I missed them because of these biases, so that’s something that now I’ve added to – you could say – my latticework of models, if you will, which is pay attention when you have really bad industries go through some rationalizations because if you can actually get some dynamics there, the pain may already be gone and the upside can be quite significant.”
Overall, to be the best investor you possibly can, you need to keep learning:
“I think the key to investing is to be a learning machine and to look at the same data that everyone is looking at. You don’t get an information advantage; what you’re looking for is that analytics advantage. Just take a step back and sometimes you can see the forest for the trees.”
Disclosure: I do not own shares in any stock mentioned in this article.
